Making Debt Pay Off Financing A Car With Savings Kept In The Bank

Everyone has received this advice: It's always best to stay out of debt. Paying cash on the barrelhead is preferable to borrowing and paying interest. It makes sense, but it's not always true.

For example: It may not be cheaper -- in the long run -- to pay $10,000 cash for a new car than it would be to borrow the money for the car. Even if a car buyer borrowed $10,000 for four years at 12 percent simple interest, and put his $10,000 cash in a certificate of deposit that yields only 8 percent a year, he will come out ahead at the end of four years by borrowing.

At first glance, it doesn't seem reasonable that paying out 12 percent interest while bringing in 8 percent is a winning proposition. The key to making this work is that the certificate of deposit is a continually growing sum of money, while the loan is a continually shrinking sum of money that demands incrementally smaller interest payments each month, said Frank Dasse, professor of economics at the Roy E. Crummer graduate school of business at Rollins College.

On the hypothetical $10,000 car deal, the buyer has put his $10,000 cash into the certificate of deposit and borrowed $10,000 for the car at 12 percent interest. There is no down payment or trade-in, for the sake of simplicity.

After the first year, the certificate of deposit has increased in value to $10,800, and after four years to $13,605. That's a gain of $3,605 in interest. Meanwhile, each month he is paying out 12 percent interest on the borrowed $10,000 that, after four years, totals $2,640.25. The difference is a net gain of $965.

Another advantage of the plan is that it conserves liquid assets. In other words, it's good to have cash in the bank in case of emergency, Dasse said.

William H. Siegrist, a Sun Bank vice president and personal banker, said the majority of consumers are not aware they can be better off borrowing than taking their cash out of interest-bearing accounts. ''As a consumer lender we have brought this to some people's attention who have the money they can put away in a CD and not worry about,'' Siegrist said.

He said he would not recommend it for someone who might have to break into the CD in the event of a financial crunch. ''That would defeat the purpose of the whole thing,'' Siegrist said.

According to a 1984 survey by J.D. Power & Associates, an automotive market research firm, one third of the people who buy cars pay with cash, and many of the others could pay cash.

Dasse also said the success of such a strategy depends on the consumer's tax bracket; those in the upper tax brackets would lose up to 50 percent of their gain from the certificate of deposit because of tax on the interest.

''This might work better if you're investing in tax-free municipal bonds,'' Dasse said. It also works if the consumer itemizes deductions on his tax return or the tax on earnings wouldn't be balanced by any deductions for loan interest, he said.

Most important, the consumer must have the money for the car. The old adage of ''it takes money to make money'' applies here perfectly.

Arnold Howell, partner in the Orlando accounting firm of Colley, Trumbower and Howell, said he would prefer to pay cash for his car and then take what he would have paid as a monthly car payment -- interest and all -- and deposit that into a high-interest savings or money market account. ''I think you would come out just as well or better,'' he said.

Siegrist agreed with that approach, and said it also would produce a profit for the consumer. But he cautioned that a forced type of savings usually demands a discipline most people simply don't have.